Business transactions tend to be surrounded by a number of questions and concerns, particularly in the case of mergers and acquisitions. Either party involved would be remiss to jump headlong into such a situation without some level of planning and negotiation. At the same time, neither wants to be legally bound to the other party’s terms before having a chance to voice an opinion on the conditions of the transaction. This is where a Letter of Intent comes into play.

What is a Letter of Intent?

As the title indicates, a Letter of Intent essentially states the intentions of the acquiring firm as they apply to the target company. Via this type of document, the former clues in the latter regarding plans for the deal in question. This could be considered a middle ground between the concept stage of a merger or acquisition and finalization.

Recipients of the document may agree with the terms provided, counter with an edited version or respond with a different set of conditions entirely.

Which Items Should a Letter of Intent Contain?

First off, the presenting firm should provide a brief introduction in a conventional Letter of Intent pinpointing both companies to be involved. This would be followed by information pertaining to the previously-mentioned terms and conditions of the transaction. This type of declaration should likewise dictate a time frame in which the deal is expected to be completed as well as any requirements applying to the financial aspects of the agreement.

A list of the assets and liabilities to be included in the transaction should be documented as well. Depending on the type of company to be purchased or taken over, certain clauses may also need to be included regarding current employees. These fall into the category of special warranties. Such statements are defined as conditional elements of an agreement.

How Does an LOI Differ from a Memorandum of Understanding and a Contract?

The key difference of these components is the extent to which each is legally binding. A Letter of Intent is generally not considered legally binding as it is part of the negotiation process and precedes the memorandum of understanding and the final contract. That being said, inclusion of certain binding elements in a Letter of Intent is advised, such as:

Non-Disclosure Agreements: Stipulations identifying details to be kept confidential throughout the course of the transaction. While each party involved has a right to obtain information about the other, neither is allowed to share these findings with parties not included in the transaction.

Non-Compete Agreements: In many cases, both the acquiring and target firms will agree to refrain from attempting to acquire the other’s current clientele or employees. Those are only two of the most common legally binding clauses stipulated in a Letter of Intent. Some may also include agreements promising reimbursement of relevant costs in the event the transaction is not completed.

When these types of statements are incorporated in an agreement, they need to be clearly identified and specified as such. The target firm has a legal right to agree or disagree with each point covered in this document and request changes as deemed fit.

Once both agree to all terms and conditions set forth, a memorandum of understanding will be drawn up followed by the final contract, each of which will be legally binding.

Why is an LOI Important in Mergers and Acquisitions?

A Letter of Intent is designed to formalize and foster business negotiation processes while offering both parties a certain degree of protection. Though terms and conditions should be outlined in this type of document, legal advisors caution against the inclusion of excessive details. Doing so could negate the overall purpose of the LOI, rendering it a legally binding agreement in court.

In short, LOI’s should succinctly describe the presenting firm, its target company, overall intentions with the merger or acquisition, financial expectations, the period of time in which the transaction is expected to be completed and conditional aspects. It is not a legally binding document though certain restrictive clauses may be included.

A Letter of Intent is a tool meant to protect the rights of those involved and allow each firm a voice in the process. Once an agreement is reached, the parties will proceed to a legally binding memorandum of understanding and, ultimately, a final contract.